Paul Krugman skillfully dissected many arguments for protectionism and industrial policies in the book Pop Internationalism. Now he seems to have fallen prey to many of these misconceptions. But first let me acknowledge that there is a semi-respectable argument that can be made against countries running large trade surpluses in a world economy that is stuck at the zero rate bound. I don’t agree with that argument (monetary policy isn’t really out of ammo), but I can see why someone like Krugman might find it appealing. I seem to recall him explicitly making this point in earlier posts. But with each new column, the arguments seem cruder and more simplistic:

And in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs. Again, anyone who asserts otherwise is claiming that China is somehow exempt from the economic logic that has always applied to everyone else.

Here he seems to have shifted his ground. No longer is a liquidity trap required, now merely a “depressed economy” is required for Chinese trade surpluses to depress aggregate demand in the rest of the world. I know of no respected macro model that supports this claim. And I’m guessing that for most of the rest of my life Krugman will consider our economy to be “depressed,” whether interest rates are zero or not.

Some background: If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality “” namely, that China is deliberately keeping its currency artificially weak.

The consequences of this policy are also stark and simple: in effect, China is taxing imports while subsidizing exports, feeding a huge trade surplus. You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.

I have no idea what this means. The standard argument is that trade surpluses (actually CA surpluses) are caused by excesses of domestic saving over domestic investment. Now it may be true that a government can cause that to happen by purchasing vast quantities of foreign exchange. And arguably China has done that. But every country in history with a trade surplus? Is the Swiss trade surplus also some sort of government conspiracy? Or might it reflect an imbalance between private saving and private investment in Switzerland? Unless Krugman wants to tautologically define “undervalued currencies” as currencies in countries with trade surpluses, I can’t imagine what point he is making.

BTW, if he intended a more sophisticated argument that currencies were undervalued any time the country’s government purchased foreign exchange, that argument would be equally fallacious. It is quite possible for every country in the world to buy foreign exchange, but clearly every currency can’t be undervalued. Krugman’s smart, so I probably misread him. Tell me what he meant in the comment section.

So what should we be doing? U.S. officials have tried to reason with their Chinese counterparts, arguing that a stronger currency would be in China’s own interest. They’re right about that: an undervalued currency promotes inflation, erodes the real wages of Chinese workers and squanders Chinese resources. But while currency manipulation is bad for China as a whole, it’s good for politically influential Chinese companies “” many of them state-owned. And so the currency manipulation goes on.

Clearly, nothing will happen until or unless the United States shows that it’s willing to do what it normally does when another country subsidizes its exports: impose a temporary tariff that offsets the subsidy. So why has such action never been on the table?

Krugman’s made it clear that trade surpluses always represent undervalued currencies. There are no exceptions in all of world history. And undervalued currencies are export subsidies (again in his view, not mine.) So is he saying the “normal” thing to do is to put tariffs on every single country that has a trade surplus? Or on any government that buys foreign exchange?

Aside from unjustified financial fears, there’s a more sinister cause of U.S. passivity: business fear of Chinese retaliation.

Consider a related issue: the clearly illegal subsidies China provides to its clean-energy industry. These subsidies should have led to a formal complaint from American businesses; in fact, the only organization willing to file a complaint was the steelworkers union. Why? As The Times reported, “multinational companies and trade associations in the clean energy business, as in many other industries, have been wary of filing trade cases, fearing Chinese officials’ reputation for retaliating against joint ventures in their country and potentially denying market access to any company that takes sides against China.”

Similar intimidation has surely helped discourage action on the currency front. So this is a good time to remember that what’s good for multinational companies is often bad for America, especially its workers.

Sinister? I feel like I’m reading Pat Buchanan here. In all of economics there is no more discredited theory than the view that “dumping” hurts the importing country. I thought Bastiat had disposed of that fallacy 170 years ago. What’s even more ironic is that the Chinese are accused of dumping green products. Think about it. Krugman’s already suggested we might want to put barriers on Chinese products because they emit so much CO2, now he’s suggesting that we should put tariffs on Chinese green products, thus raising their price and discouraging the rest of the world from installing solar panels. Once you start looking at the world from a left-wing perspective, it seems there is no end to the number of reasons you can find to abandon free trade.

What would really be bad for American workers? It would be to make the same mistakes we made in 1930. To mindlessly lash out at foreigners because we are too lazy or too stupid to tell our own Federal Reserve to boost NGDP.

Krugman has told the Fed to get moving. I wish he’d stick to that message.

PS. Ryan Avent was even less impressed than I was, and found lots of other problems.

I think that’s pretty interesting how Paul Krugman is able to pile all these economic fallacies on top of each other and coincidentally get things exactly right when it comes to monetary policy.

Btw, one way I disagree with you is that we can do more than rely on monetary policy. One way we can get NGDP back up where God intended it, is to basically ban or regulate a lot of the “leakage” that occurs in the economy where people obtain goods and services though interactions that don’t involve money changing hands. These malicious activities are keeping NGDP well below where it needs to be — not to mention depriving the Treasury of income it’s rightfully due.

I still think Warren Buffet’sImport Certificates 7-year-old idea is worth a try as a non-trade-war inducing way to ensure balancing and neutralize the effects of distortions or manipulations. I’d at least like to see it tried somewhere in the 21st century economy.

Krugman being against free trade does not surprise me. If one moves in political circles (whether left or right) for long enough, it is extremely tempting to be seduced by the siren of protectionism. It is especially powerful for members of a country like the USA, since it is conceivable that the United States could produce many things domestically and out-gun any nation in a trade-war. The US are in a position to contemplate producing their own steel (the ultimate protectionist paradise, curiously); that’s a less attractive idea for Denmark or even the United Kingdom.

What does surprise me is that Krugman is putting forward such hackneyed 18th century arguments for protectionism, rather than say national security concerns. It’s not like he has an excuse that this is outside of his field.

More and more, this feels like the 1930s, with a less incendiary international situation.

Why are you skirting around the main issue. Why shouldn’t the Chinese allow the renminbi to float? In a previous post, you wrote that it was good that the Chinese did not let the renminbi appreciate versus the dollar in early 2009. But wouldn’t it have remained depressed versus the dollar anyway if it was floating (just like all the other developing world currencies around that time)?

I find it funny that Krugman and I arguing for free markets here against conservatives who don’t seem to see the problems that a fixed currency in a floating currency world creates.

Indy. That’s not Buffett’s idea; an Australian I know published that idea around the late 1980s.

I don’t view the trade deficit as a problem, but for those who do, I suppose it’s an interesting idea.

Rebecca, Agreed.

Morgan. I guessing that involves getting lower housing prices.

Silas, Yes, I saw it was satire. Not sure what sort of comment was called for. Banning barter is obviously not my policy–indeed I want more monetary stimulus so that we stop doing all these other inefficient interventions.

Benjamin. Great. Do you have a link for those of us who don’t have the paper copy? Or can you summarize the letter?

W. Peden, Good observations.

Liberal Roman, I have no problem with China floating the yuan, I object to protectionism. Denmark’s currency doesn’t float either.

In any case, as long as they bought lots of foreign assets, letting it float would not reduce the Chinese trade surplus. They’d have to stop accumulating foreign exchange. And there is no guarantee that even that would work.

I think Krugman is saying that ceteras peribus, if a currency is made weaker artificially, then a country will have greater exports and fewer imports than if the currency were higher.

So: if weaker currency –> greater trade surplus.

You are reading him as saying: greater trade surplus –> weaker currency.

He’s not saying that every country with a trade surplus has an artificially weak currency. He is saying that every country with an artificially weak currency has a greater surplus (or smaller deficit) than it otherwise would have without the artificially weak currency. So the Swiss and Germans don’t count.

Regardless, you are right that it’s ridiculous to blame the Chinese. We could easily take control of our own AD demand situation. As the old (and good) Krugman once said about NAFTA: What will be the impact of passing NAFTA on aggregate employment in the US? None.

Regarding George Melloan’s “The Fed Can Create Money, Not Confidence” (op-ed, Aug. 24): The reality is even grimmer than the Federal Reserve’s lack of confidence-building powers, and that is that public agencies inevitably fight the last war. Thus, we have federal agencies devoted to fighting poverty and racism, others to helping farmers, and yet others still preserving their Cold War formations. It is ever 1962 in Washington, D.C., except at the Agriculture Department, where it is still 1932.

The Federal Reserve is more up-to-date””it is 1972 there. The Fed is fighting its last war, even as our economy sags and deflation is knocking at the door.

I agree with TravisA. Krugman is making a relative point. It was shocking to see Krugman reference “jobs.” Paul must believe China’s artificially weakened currency pulls productive, high paying jobs from the U.S. to China.

Silas, we would not be a free country if we banned voluntary trade without money, it just needs to be better structured where we educate ourselves for it and provide 20 percent directly back to the government, making the choice as to what we give back, that is, direct democracy through direct economies.

Morgan, we can take care of those sticky wages in a hurry if we take care of our own social services so that we can equalize with other countries and get our factories back. That way we can let money do what it does best, represent physical commodities, physical assets and the kinds of resources one can see and touch.

But on the main point, yeah, I find it totally confusing, depressing, and bizzare that he is holding the People’s Bank of China to a much higher standard than the Fed, and advocating policies that could totally **** up the relationship between the two most powerful countries in the world.

What is an artificially undervalued currency? Dunno, maybe something to do with PPP? Or sterilized buying of foreign exchange? I.e. not only targeting a particular exchange rate, but taking deliberate measures to offset its stimulatory/inflationary effects e.g. controls on domestic lending. Which describes the Chinese policy of the last decade not too badly (although maybe not the last year or 2!).

Silas, Yes, I saw it was satire. Not sure what sort of comment was called for. Banning barter is obviously not my policy-indeed I want more monetary stimulus so that we stop doing all these other inefficient interventions.

But why don’t you think banning home-cooking or non-monetary sex would be effective at appeasing the NGDP god?

“Recall he thinks the BOJ is earnestly trying to inflate, but just can’t quite get the hang of it.”

I’m not sure why anyone would believe that Japan wants to inflate.

With debt approaching 200% of GDP, I don’t see why Japan would want to see ~2% inflation and as a consequence be rolling over its short term debt at 2%-3%. With 10 year rates around 1%, the interest burden of the debt is probably something less than 1% (say 0.8%). Going from 0.8% to 2.4% would raise the debt burden as a percent of GDP from ~1.6% to ~4.8%, probably offsetting any budget improvement from faster NGDP growth. So while Japan’s macro situation is better and is probably characterized by ~3.5% NGDP growth, the annual deficit remains near double digits as a percent of GDP and the interest burden grows with each rollover.

Throw in a whiff of credit risk and Japan would be in a rough spot.

I might be missing something here, but it seems to be Japan’s best strategy is to keep inflation/interest rates low. Maybe getting to 2% inflation would work for Japan, but it seems awfully risky to me.

As an aside, many of these bonds are held by Japanese investors. A relatively quick surge in yields from 1% (10yr) and 2% (30yr) to 4% for each will create something on the order of a 20%-30% capital loss to the existing holders of these bonds. Granted many institutional investors hedge interest rate risk, but someone is going to be left holding the bag.

Silas, we would not be a free country if we banned voluntary trade without money, it just needs to be better structured where we educate ourselves for it and provide 20 percent directly back to the government, making the choice as to what we give back, that is, direct democracy through direct economies.

That was satire, sweetheart. I wasn’t seriously suggesting that voluntary non-money exchanges be banned (which would include self-exchanges such as cooking for yourself). My point was that advocacy of such asinine policies follows directly from scott_sumner’s position that economic health requires that we take whatever steps are necessary to restore NGDP to +5% growth trend, no matter how patently destructive they are.

“The standard argument is that trade surpluses (actually CA surpluses) are caused by excesses of domestic saving over domestic investment.”

That doesn’t sound right to me. The level of the CA surplus is simultaneously determined with the levels of saving and investment, but the levels of one do not cause the levels of the other. If the quantity that a country wishes to invest and the quantity it wishes to save are both fixed (inelastic) at certain levels, then those quantities will determine the CA surplus, but they will do so largely by affecting the exchange rate. (For example, the excess saving will bid down domestic interest rates, thus making the domestic currency less attractive and causing it to depreciate, so that domestic goods become more attractive relative to foreign goods, thus inducing a CA surplus.) The exchange rate is still the proximate cause of the CA surplus. There is no “immaculate transfer.”

“if he intended a more sophisticated argument that currencies were undervalued any time the country’s government purchased foreign exchange, that argument would be equally fallacious. It is quite possible for every country in the world to buy foreign exchange, but clearly every currency can’t be undervalued.”

The argument would be that currencies are undervalued whenever governments collectively engage in reserve transactions that result in a (sufficiently large) net increase in the availability of that currency in foreign exchange markets. (Obviously if the US were to offset China’s dollar purchases by buying yuan, this would not be the case.)

That seems like a pretty good argument to me: if the value of the currency is what the private sector would determine it to be in the absence of official reserve transactions, then it is fairly valued (on the assumption that private markets are efficient enough to give it a fair valuation). If net official reserve transactions are reducing the actual market value of the currency relative to that “fair” market value, then it is undervalued.

Think back to your earlier analogy, that if all countries intervene in forex markets, and buy each others’ bonds, it is like every country doing QE. Which is good. But if the Bank of China can buy US bonds, but the Fed can’t buy Chinese bonds (because China won’t allow it), then it’s asymmetric.

Paul Krugman: “You may see claims that China’s trade surplus has nothing to do with its currency policy; if so, that would be a first in world economic history. An undervalued currency always promotes trade surpluses, and China is no different.”

Scott Sumner: “I have no idea what this means. The standard argument is that trade surpluses (actually CA surpluses) are caused by excesses of domestic saving over domestic investment.”

Scott,

I’m not sure what your problem is. Maybe it would be easier if I amend Krugman’s statement as follows: an overvalued currency always promotes trade deficits. Presumably if you accept that, you accept Krugman’s statement also. It’s easier for me to think of it that way, because that was the Irish situation when I was a student. We had an overvalued currency and controls which restricted outflows of capital – pretty much the inverse of the Chinese situation.

Here’s how a typical Irish economics lecturer would introduce the topic in those days: draw a production possibility frontier with non-tradables on the vertical axis and tradables on the horizontal axis. To the right of it draw an “indifference curve” representing demand for the two goods. (Mumble something about aggregation problems at this point and hurry along.) The exchange rate determines the relative price of tradables and non-tradables. You can fill in the rest yourself. I’ve reproduced the blackboard here. In more advanced we got calculus, but the moral was the same.

Silas, It might boost NGDP, but there would be a heavy cost. Money creation is FREE.

Justin, That’s actually a very complicated issue. For instance, unanticipated inflation would help the Japanese government, by reducing the real value of their existing debt. You make a good point, but higher trend inflation also allows them to issue more new nominal debt, w/o increasing their real debt burden. So I think inflation might well help them.

Andy, Nick, Kevin, Thanks for the good comments, I tried to address some of them in a new tirade, er, I mean post.

Krugman suffers the fate of being right, again and again on things that occur in the future. And it ticks off people who disagree with him.

No more “18th century” references. We were a net creditor on both fiscal and trade fronts then. As a net debtor, the “lessons” of past debacles are now irrelevant.

Tariffs on Chinese imports, taxes imposed on domestic based multinationals for offshored jobs, the elimination of R&D credits for equipment purchased from abroad are all necessary measures to restore domestic employment.

The call for global wage standards doesn’t take into account domestic damage. A domestic worker earning $40K is equivalent to a Chinese worker making $4K. Do you think American workers can live on $4K per year?

You are right in the sense that the U.S. could produce what it needs domestically (sans oil), but doesn’t because it is cheaper elsewhere. The goal should be to no longer permit it to be cheaper elsewhere, and restore full employment, with tariff revenues and taxes on offshored labor to boot. If this sounds antiquated, so be it. We were the holders of capital then, we are the debtors now.

Throw out all the econometric arguments you want against this, but the fact of the matter all such models focus on maximum utility for all, but are not country specific. There really are winners and losers everywhere, and we can see which category we are falling into.

Retaliation is not an issue. Our primary exports are immune from retaliation. Is China going to impose tariffs on our food exports, and starve their countrymen? Who cares if they place tariffs on our technology, entertainment and related IP exports? They already pirate so much of it.

Tax lawyer, You should read “Pop Internationalism” by Paul Krugman, you’d find out that the arguments you made here are wrong.

BTW, was Krugman “right” when he said in 1985 that the US would not be able to run persistent CA deficits for 23 years?

And you seem to have responded to claims I never made, such that we needed to lower American wages to Chinese levels.

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.